Modi and the sunk cost fallacy: For BJP demonetisation too big to fail

If demonetisation was a product of 'group think' where dissenting views were absent, the government's actions post-November 8 are becoming an example of the sunk cost fallacy.February 06, 2017, 09:07 IST

To students of eco- nomics, cost-benefit analysis is a foun- dational concept. The government has not only largely disregarded the costs of demonetisation, it has doubled down on the scheme's ability to "transform" India. The packaging and marketing of demonetisation may impress many, but its adverse impacts are becoming clearer with each passing day.

The government has pegged 2016-17 GDP growth at 6.5% and revised downward the 2017-18 growth rate. But it continues to do all it can to justify the PM's original decision as a "bold and disruptive reform". No objective is now bigger, it appears, than making the scheme appear successful. If demonetisation was a product of 'group think' where dissenting views were absent, the government's actions post-November 8 are becoming an example of the sunk cost fallacy.

Individuals become victims of the sunk cost fallacy when they persist with a task to which resources have been committed even after evidence emerges that the task is unlikely to be successfully completed. Imagine you begin watching a 15-episode TV series. After watching five episodes, you realise that you are not enjoying the show as much as you had expected. You want to stop but you feel invested in the show.

Stopping now would mean that you wasted time on those early episodes. Why not watch the entire series? This is where sunk costs come in. Time spent on the first five episodes is a sunk cost. It is unrecoverable. What can be saved, however, is the time that would be spent watching the remaining 10 uninteresting episodes.

That brings me to Prime Minister Narendra Modi's demonetisation scheme, which was portrayed as a "surgical strike" on black money, corruption, terrorism and counterfeiting. Over time, it has become painfully clear that those objectives have not been met. Deep rooted problems like corruption or terrorism are not amenable to blunt, one-off policy instruments.

A one-time currency withdrawal could at best cauterise a portion of black money held in cash. However, even in that limited objective the government appears to have failed. Reports indicate that almost all of the withdrawn notes were deposited in banks.

RBI has failed to provide official data, but if Rs 3-5 lakh crore had stayed out of the banking system, the scheme's supporters would have hailed it as India's version of the cancer moonshot. The government may cling to hopes of an income tax bonanza after scrutiny of deposits. But realistically the task to analyse the data, identify suspicious transactions, file cases and resolve them will likely take years.

The PM is too smart a man not to understand that demonetisation failed in its stated objectives. Worse, evidence emerged of an economic slowdown and job losses in the informal sector. The poor appear to be worst hit. Some of finance minister Arun Jaitley's budget proposals acknowledge this.

All this is happening at a time of key state elections. For the PM, accepting failure was not an option. He was invested in the demonetisation scheme and he would do whatever it took to justify his initiative. After casting demonetisation as a "war" against the "corrupt" he asked people to make sacrifices in the national interest. The government's methods became increasingly coercive and desperate. Every day, it seemed, a new order would be issued making it progressively harder to deposit old notes.

The government also promulgated an ordinance that imposes a penalty, including a jail term, for possession of the scrapped notes beyond a March deadline. RBI became a laughing stock, its institutional integrity and credibility severely damaged. The scene of a des- perate woman, unable to exchange her old notes, taking off her clothes as a mark of protest outside RBI's gates was symbolic of an institution in tatters.

Demonetisation's goalposts shifted with absurd frequency, eventually settling on India's transition to a cashless economy. Lotteries were announced to promote cashless payments, new mobile payment apps were hastily launched, and a slew of ideas, including one in which cash transactions would be taxed, began percolating to paper over the original sin.

The war on cash is truly on. However, if the government isn't more careful and thoughtful about India's transition to a less cash economy, the victims in this war could be India's poor and voiceless.

For now, it is gratifying to see that Jaitley's budget did not announce any major untested ideas. But that is cold comfort to those concerned by how the demonetisation scheme morphed into the cashless society idea. As with demonetisation, there is little evidence of serious debate on the challenging issues that surround the transition to a less cash economy.

From my experience at the World Bank, teams there spend months vetting projects even if they are worth only a few million dollars. This vetting is important because we know that socio-economic development is messy. Ideas must be thought through and safeguards built in should things not work out the way everyone had hoped. Therefore, it is shocking to see the lack of comprehensive and inclusive debate on initiatives that could have serious repercussions for a multi-trillion dollar economy and a billion plus people.

The PM packages and markets his ideas brilliantly. Some of his ideas appeal to our aspirations. But in the absence of deeper thinking, proper planning and efficient execution, the PM's ideas can impose a heavy cost on ordinary people. He must recognise the dangers of the sunk cost fallacy and cut his losses. It is also important for the PM to recognise that the losses are not his alone.

The writer, formerly with the World Bank, is a spokesperson for Congress. Views are personal

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